CFDs are high-risk, complex and costly financial products. Most people lose money trading CFDs.
What are CFDs
A CFD is a financial product used to speculate on changes to the price of an underlying asset. Underlying assets can include shares, commodities, currencies, crypto assets, indices or even other derivatives.
A CFD is a type of derivative – its value is based on the value of the underlying asset. You don’t own the underlying asset and have no rights to it.
It is effectively a bet on whether the value of the underlying asset is going to rise or fall in the future. This is compared to the value when the CFD contract is opened.
CFDs are leveraged products, which means you are borrowing money (known as ‘margin’) to invest more. A small price change against a leveraged CFD position can have a big effect on trading returns or losses. You could even lose your entire investment.
How CFD trading works
In Australia, CFDs are only available to trade ‘over-the-counter’ – they are not traded on a licensed exchange. This means a CFD is a contract, between you and the issuer. You both agree to pay the difference in price of an underlying asset between the open and close of the contract.
- If you buy a CFD (a 'long trade') – the issuer will pay you the difference if the price increases, and you will pay the issuer if the price decreases.
- If you sell a CFD (a 'short trade') – the issuer will pay you the difference if the price decreases, and you will pay the issuer if the price increases.
The money you make or owe under a CFD won’t be the exact difference in price. This is because CFD trading often incurs fees and costs, including commissions, spreads and overnight financing fees. These fees and costs can be high. They can cut into any profits you make, and also make your losses worse.
A CFD contract is legally binding. If the market goes against you, the CFD issuer may:
- ask you to pay extra money at short notice to keep your CFD position open (a 'margin call'). This may lead to further losses;
- close out your CFD, for whatever it's worth at the time. You may lose all the money you invested.
CFD contracts are not all the same. Every CFD issuer has their own terms and conditions. You rely on the issuer to fulfil their obligations to you.
Look for details in the product disclosure statement (PDS) and terms and conditions.
CFD sale restrictions
There are restrictions on the sale of CFDs to retail investors in Australia.
CFD issuers must:
- apply 'margin close-out protection', to end one or more open CFDs before all or most of the investment is lost
- limit retail client losses by providing 'negative balance protection', so they can never lose more than they invest
They must not:
- exceed specific leverage ratio limits, depending on the CFD asset class
- offer incentives to trade CFDs, such as trading credits and rebates, or 'free' gifts like iPads
Read more about ASIC’s CFD Product Intervention Order.
Why CFDs are high risk
Most CFD investors lose money. Recent data released by ASIC revealed that at least 68% of retail investors lost money trading CFDs. Some CFD products are worse than others – 85% lost money trading CFDs over options. The more you trade, the more you lose – especially after fees. Most retail investors stop trading CFDs within their first year.
CFDs are complex and high risk. Even experienced investors may struggle to understand the risks and complexities of trading CFDs. Here we explain the risks.
Leverage can lead to large losses
CFD leverage is like trading with borrowed money. The deposit (or 'margin') you give to the CFD issuer is a small part of what you borrow to invest.
Leveraging and trading on margin is high risk. A small price change against your CFD position can have a big effect on your trading returns or losses. You can quickly lose your entire investment.
For example, you may have to put up $5,000 (5%) for a $100,000 contract. This means you are borrowing the other 95%. A 5% fall in the underlying asset price could mean you lose your $5,000.
Pricing and counterparty risks
CFDs are a contract between you and the CFD issuer. The CFD issuer sets the prices for the CFDs they offer, and the price that your contract is opened or closed can change unexpectedly. Price risks that you may be exposed to include:
- gapping – when underlying markets are volatile, where the market price moves in large and discrete steps and skips one or more price points.
- slippage – when underlying markets are illiquid, the price at which the CFD order is executed can differ from the price quoted.
When you trade CFDs, you are also exposed to counterparty risk to the CFD issuer. CFD issuers have certain financial services licensing obligations relating to financial requirements, risk management and client money handling. But if something goes wrong, you might not get your money back. For example, if the CFD issuer goes into administration.
Consumer protection may not apply with overseas CFD providers
CFD issuers operating in Australia must have an Australian financial services (AFS) licence.
Overseas CFD providers often don't hold an AFS licence, so consumer protections available under Australian laws will not apply.
This means you will not have access to independent dispute resolution through the Australian Financial Complaints Authority (AFCA). If something goes wrong, you may not be able to get help.
Before you trade CFDs, check the provider has an AFS licence on ASIC's Professional Registers Search. If they don't have one, don't deal with them.
If the overseas provider does not hold an AFS licence, it could be a scam.
Wholesale clients lose consumer protection
Some CFD issuers may try to offer you a “pro account”. This means you might be classified as a ‘wholesale client’, taking away many consumer protections that you would have as a retail client.
If you are a wholesale client, you:
- can lose more than you invest, as you may not have 'negative balance protection' or 'margin close-out protection' on your CFD;
- waive your right to use the CFD issuer’s internal dispute resolution service;
- cannot get external dispute resolution through AFCA;
- may not receive a product disclosure statement (PDS) or Financial Services Guide (FSG) for the CFD
- will not be assessed to see if you fit the licensee’s target market
To check how you are classified, read the PDS issued by the CFD provider.
Check if you understand CFD risks
CFDs are often promoted in an attractive way and can seem appealing.
But, before you believe that online ad, or the finfluencer, or the friend of a friend, stop and ask yourself if you really understand what you’re investing in. And if it’s worth the risk.
Ask yourself these questions:
- Do I understand how CFDs work, and am I comfortable with taking that level of risk?
- Am I willing and able to lose my entire investment?
- Do I know what the fees and costs are to trade CFDs? How will this affect my potential losses or profits?
- Do I really have the time to be monitoring my positions regularly?
- Does the CFD provider have an Australian financial services (AFS) licence?
- Should I really be trusting the opinion of the person trying to sell me a CFD?
- Am I making a logical decision with my money, or is this just investment hype?
Finding the right investments can be challenging. If you need some help to build a diversified portfolio, talk to a financial adviser.